Selling a medical practice: what physicians keep after tax

Two checks from the buyer, taxed in two different ways

A physician selling to a hospital or a private equity platform almost always signs two documents at once: a purchase agreement for the practice and an employment or professional services agreement for the years after closing. Money under the first can be capital gain. Money under the second is wages, reported on a W-2 and subject to payroll tax under IRC 3101 and 3121, whatever the parties call it. Buyers care about their total cost; you care about which document each dollar sits in.

Private equity buyers usually pay a meaningful price for the practice and then reset physician pay lower (the "scrape" that funds their margin). Hospital systems tend to do the reverse: modest price, higher fixed salary. Our worked example shows why that difference is worth real money even when the total is the same.

Why hospitals often will not pay for goodwill

Hospitals bill Medicare for services their employed physicians order, so a practice purchase is a financial relationship under the physician self-referral law (the Stark law). The isolated transaction exception, 42 U.S.C. 1395nn(e)(6), lets a hospital buy a practice only if the price is consistent with fair market value and not determined in a manner that takes into account the volume or value of referrals. The federal anti-kickback statute adds criminal exposure for paying to induce referrals.

The practical result: many hospital valuations assign little or nothing to goodwill, on the view that a practice whose patients follow the doctor has no transferable goodwill apart from the doctor, who is being hired anyway. That pushes value into compensation, which must itself be fair market value for the work. A private equity group that does not own a hospital has more room to pay for goodwill, which is one reason PE prices look higher on paper.

The professional corporation trap

Many medical groups incorporated decades ago as professional corporations and never elected S status. A C corporation selling its assets pays the flat 21% corporate tax (IRC 11(b), 2026) on the gain, then shareholders pay capital gains tax again when the corporation liquidates (IRC 331). On a $1 million gain, the corporate layer alone is $210,000 before any physician sees a dollar.

Three common responses, each with conditions:

• Personal goodwill. If no employment agreement or non-compete ties the physician's patient relationships to the corporation, the physician can sell personal goodwill directly. Martin Ice Cream Co. v. Commissioner (110 T.C. 189, 1998) supports this; Howard v. United States (E.D. Wash. 2010) shows how a non-compete with your own corporation defeats it. In Derby v. Commissioner (T.C. Memo. 2008-45) physicians who claimed large goodwill values when transferring their practices to a medical foundation saw the court allow far less. See personal goodwill sale.
• Stock sale. Selling the shares avoids the corporate layer, but most hospital and PE buyers want assets to step up basis; see asset sale vs stock sale.
• S election years earlier. Converting to S status starts a built-in gains period (IRC 1374) that is too slow to help a sale already on the table.

QSBS will not rescue a PC: IRC 1202(e)(3)(A) excludes health services. More on the corporate layer at C corporation sale double tax.

Receivables: the large ordinary-income piece most physicians forget

A cash-basis medical practice often has 30 to 60 days of billed but unpaid insurance claims. Those receivables have zero tax basis and are not capital assets (IRC 1221(a)(4)), so every dollar collected or sold is ordinary income. Many deals leave receivables with the seller to collect over the following months, which spreads the ordinary income into the next tax year when closing is late in the year. If the buyer purchases them, expect a discount for collection risk, and the price is still ordinary.

Equipment is smaller in most primary care and specialty practices than in dental or imaging, but anything you expensed under Section 179 or bonus depreciation comes back as Section 1245 recapture, taxed in the year of sale even when the price is paid later (IRC 453(i)). See depreciation recapture.

Worked example: the same $1.21 million, two labels

A married physician in Illinois has $450,000 of other income and sells a practice. Illinois taxes all income at a flat 4.95% (35 ILCS 5/201, unchanged since July 1, 2017), so the state bill is the same either way. The difference is federal.

In the first version, a private equity group pays $900,000 for personal goodwill, the physician keeps $250,000 of receivables and the buyer pays $60,000 for fully depreciated equipment. The sale adds $370,697 of tax, an effective 30.6% on $1,210,000. The calculator counts the receivables in the 3.8% net investment income tax base, which overstates that line for an active physician.

In the second version a hospital values goodwill at zero and pays the same $900,000 as signing and retention bonuses over the employment term. Now the tax is $541,438, or $170,741 more, because compensation is taxed up to 37% (Rev. Proc. 2025-32, 2026) instead of 20% on long-term gain. The 3.8% line in this version stands in for Medicare tax: 1.45% employee plus 0.9% Additional Medicare above $250,000 for joint filers (IRC 3101(b), not indexed) plus the 1.45% employer share (IRC 3111(b)). See Illinois capital gains.

Non-competes: tax and state law pull in different directions

For tax, a non-compete paid to you is ordinary income and gives the buyer the same 15-year amortization as goodwill (IRC 197(d)(1)(E)), so allocating price to it is a loss for you and no gain for the buyer. For enforceability, physicians are treated differently from most sellers, and the rules are moving:

• Texas: a physician non-compete must include a buyout at a reasonable price and access to patient lists and records (Tex. Bus. & Com. Code 15.50(b)); 2025 amendments added further limits, so check the version in force when you sign.
• Minnesota: non-competes are void for employees under Minn. Stat. 181.988 (2023), but the statute expressly allows one agreed during the sale of a business.
• California: most non-competes are void (Bus. & Prof. Code 16600), with an exception for a seller of business goodwill (16601).

The sale-of-business exceptions matter because a non-compete tied to the purchase agreement is usually enforceable even where an employment non-compete is not. Your lawyer should place it in the document that fits your state.

Rollover equity, earn-outs and the after-tax comparison

Private equity offers usually include rollover equity in the platform, deferrable under IRC 721 for a partnership holding company or IRC 351 when the 80% control test is met. Some include earn-outs tied to collections, which are taxed as received under the contingent payment rules; see earn-out. A physician selling to a younger partner can report goodwill gain as payments arrive with an installment sale, secured by the practice assets and a personal guarantee. Compare each offer on cash after tax, not headline price, and test net investment income tax exposure if you will stop practicing before the money arrives.

To see every offer and deferral path side by side on your numbers, Get the Big Sale Tax Analysis.

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